Jetrader - Fall 2014 - 39

Continued from page 37
Several market participants expect the
engine operating costs during the second
decade of 777-300ER operations may be a
brutal shock to many airlines and investors.
If left unchecked over the long term,
we believe there is a strong potential for
this aftermarket to become a monopoly,
particularly on single engine choice aircraft
types: once an airline chooses its engines
where it can only opt for an OEM support
package, prices are bound to rise.

End-of-Life Engine Values
The situation on Trent and CFM56
engines has created a useful case study
for comparison and may offer some clues
as to how the market is likely to evolve.
It seems clear that excessive aftermarket
competition leads to depressed asset values
and potentially weakens OEM revenue flow.
On the other hand, a situation where there
is no aftermarket competition on any level,
where the OEM controls all aspects-spares,
replacement materials, repairs, etc.-kills
off any interest in trading used engines.
Both scenarios cause market uncertainty
and lead to heavy losses in value.
Rolls-Royce's near-total control of the
Trent market has been in existence for several years, but when combined with poor
aircraft demand, it is only now becoming
apparent how painful the implications can
be for aircraft residual values. The perceived overproduction of replacement aircraft may be the main culprit. It is difficult
to pinpoint exactly how much influence
the relative lack of engine resale values is
having on this used aircraft market, but it
is clearly not helping the situation.

Aircraft Value Impact
The two primary concerns for all aircraft
investors are stability and predictability
of residual values and security to cover
for lessee default risk. When all-inclusive
packages first appeared, investors' primary issues related to coverage for lessee
default: such packages are paid for as a
form of insurance premium for ongoing
usage whereas reserves are a buildup of collateral for future maintenance obligations;
however, these issues have recently been
further compounded by the rise in termbased pricing and the increasing uncertainty in value and maintenance costs of
mid- or end-of-life engines.

120

1/2 Life Base Value

Maint Adjusted Value

100

Engine PBH [10yr]
Full Reserves

80
60
15

40

10
5

20
0

0
0

2

0 2 4 6 8 1012
4

6

8

10

12

14

16

18

20

Figure 1
Figure 1

Any market where the resale of parts and spares
are controlled by a single entity is potentially
catastrophic for investors in aircraft as there is
no discernible floor for engine resale value.
Figure 1 is an output from Stratos' lease
simulator showing the evolution of reserves
and condition over 20 years for a typical
investor in newish widebodies. The parabolic blue line is the base value, and the
jagged red line is this base value adjusted
for intrinsic maintenance value. The dashed
yellow line shows the effect that an allinclusive package during the first 10 years
has on reserve collection rates. The green
full reserves line is where investors ideally
need to be: the synthetic full life line keeping investors fully covered in the event of
default. The difference between the yellow
and green lines is shown in the sub-graph.
These are the cash levels ($m) potentially at
risk if the lessee defaults: enough to wipe
out any investor given the wrong combination of circumstances.

Conclusion
When the demand for used aircraft falters, investors rely heavily on a functioning engine aftermarket and fully funded
maintenance reserves to recover at least
some of their losses. Any market where
the resale of parts and spares are controlled by a single entity is potentially
catastrophic for investors in aircraft as
there is no discernible floor for engine
resale value. If left unchecked, at some

point investors will stop funding these
assets. In this scenario, OEMs will probably have no choice but to stabilize their
own aftermarket, perhaps by offering
RVGs or engine buyback commitments.
In the meantime, aircraft investors are
hoping that engine OEMs are taking note
of the current used aircraft market situation and that the temptation to control
the aftermarket will be tempered with
the knowledge that such actions, when
combined with poor aircraft demand, can
kill residual values.
Some OEMs are taking some positive
steps to address investor concerns on payment and security mechanisms but investors need to continue to push for their
interests to be defended, particularly as
it relates to aftermarket trading.
Hidden terms, heavy discounting and
increasing sophistication of the all-inclusive packages make investors' evaluation
of risk all the more difficult. The biggest
losers in this situation are most likely to
be the second tier aircraft investors; they
need to tool up to analyze this risk or
face extinction.
This article is an extract from a
white paper available for viewing at
www.stratos.aero/news.
Jetrader  *  Fall 2014 39


http://www.stratos.aero/news

Jetrader - Fall 2014

Table of Contents for the Digital Edition of Jetrader - Fall 2014

A Message from the President
Calendar/News
Reach for the Stars
Beauty Contest
Boeing’s Current Market Outlook for 2014
Aircraft Recyclers Debate the Coming ‘Tsunami’ of Retired Aircraft
Engine Support Plans Shift Market
The Second Life of Aircraft: Does It Still Exist?
Restructuring Aircraft Leases in Bankruptcy
Aviation History
Aircraft Appraisals
ISTAT Foundation
Advertiser.com
Advertiser Index
Jetrader - Fall 2014 - cover1
Jetrader - Fall 2014 - cover2
Jetrader - Fall 2014 - 3
Jetrader - Fall 2014 - 4
Jetrader - Fall 2014 - 5
Jetrader - Fall 2014 - 6
Jetrader - Fall 2014 - A Message from the President
Jetrader - Fall 2014 - 8
Jetrader - Fall 2014 - 9
Jetrader - Fall 2014 - Calendar/News
Jetrader - Fall 2014 - 11
Jetrader - Fall 2014 - Reach for the Stars
Jetrader - Fall 2014 - 13
Jetrader - Fall 2014 - 14
Jetrader - Fall 2014 - 15
Jetrader - Fall 2014 - Beauty Contest
Jetrader - Fall 2014 - 17
Jetrader - Fall 2014 - 18
Jetrader - Fall 2014 - 19
Jetrader - Fall 2014 - 20
Jetrader - Fall 2014 - 21
Jetrader - Fall 2014 - 22
Jetrader - Fall 2014 - 23
Jetrader - Fall 2014 - 24
Jetrader - Fall 2014 - 25
Jetrader - Fall 2014 - 26
Jetrader - Fall 2014 - 27
Jetrader - Fall 2014 - Boeing’s Current Market Outlook for 2014
Jetrader - Fall 2014 - 29
Jetrader - Fall 2014 - 30
Jetrader - Fall 2014 - 31
Jetrader - Fall 2014 - Aircraft Recyclers Debate the Coming ‘Tsunami’ of Retired Aircraft
Jetrader - Fall 2014 - 33
Jetrader - Fall 2014 - 34
Jetrader - Fall 2014 - Engine Support Plans Shift Market
Jetrader - Fall 2014 - 36
Jetrader - Fall 2014 - 37
Jetrader - Fall 2014 - 38
Jetrader - Fall 2014 - 39
Jetrader - Fall 2014 - 40
Jetrader - Fall 2014 - The Second Life of Aircraft: Does It Still Exist?
Jetrader - Fall 2014 - 42
Jetrader - Fall 2014 - 43
Jetrader - Fall 2014 - Restructuring Aircraft Leases in Bankruptcy
Jetrader - Fall 2014 - 45
Jetrader - Fall 2014 - 46
Jetrader - Fall 2014 - Aviation History
Jetrader - Fall 2014 - 48
Jetrader - Fall 2014 - 49
Jetrader - Fall 2014 - 50
Jetrader - Fall 2014 - 51
Jetrader - Fall 2014 - 52
Jetrader - Fall 2014 - Aircraft Appraisals
Jetrader - Fall 2014 - 54
Jetrader - Fall 2014 - 55
Jetrader - Fall 2014 - ISTAT Foundation
Jetrader - Fall 2014 - 57
Jetrader - Fall 2014 - Advertiser Index
Jetrader - Fall 2014 - cover3
Jetrader - Fall 2014 - cover4
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